Department of Business Economics Master Thesis Spring 2008 Supervisor: Anders Isaksson Author: Anita Ludvigsson Momentum Investment Strategy (An Empirical Study of the Canadian Stock Market and the Swedish Stock Market) 1 Acknowledgements The author would like to thank supervisor Anders Isaksson, who supported this paper with his knowledge. Anders gave me useful guidance which helped me keep in the right direction. Additionally, I wish to thank the Library of Umeå University and the Business and Economic Department of the University for the facilities and their proper academic atmosphere. Further gratitude goes to my parents and fiancé for all their encouragements and support during the period of study. Umeå, April 2008 Anita Ludvigsson 2 3 Abstract Market efficiency is a highly debated topic within the academic research field of finance. Several studies have presented that the return on stocks may be predictable by employing the momentum investment strategy, which contradicts the Efficient Market Hypothesis in exchange market. There is extensive international evidence, on an academic level that the momentum investment strategy yields positive abnormal returns when short-term periods are considered. This paper examines the profitability of the momentum investment strategy in Canadian and Swedish stock markets during January 2000 to December 2006. To investigate the strategy, two separate portfolios of winners and losers, each portfolio containing 50 stocks, are created for each market. Then the momentum strategy, which consists in long position in past best performing stocks and short positions in past worst performing stocks, is run for each exchange market. Results show that the strategy generates statistical significance at the 5% level for Canadian market for 9-month holding period, and with the level of significance at the 10% for Swedish market for the 6 and 9-month holding periods after excluding the data for the year 2002. Moreover, results show that the strategy is even stronger in the level of significance during the bull trend of the markets. The paper confirms the existence of the momentum anomaly in TSX and SSE. 4 5 Table of contents Table of Contents 1. Introduction .......................................................................................................................... 10 1.1 Background .................................................................................................................... 10 1.2 Research questions ......................................................................................................... 11 1.3 Purpose ........................................................................................................................... 12 1.4 Definitions ...................................................................................................................... 12 1.5 Disposition ..................................................................................................................... 13 2. Stock Market Exchange and Indexes ................................................................................... 15 2.1 The Toronto Stock Exchange ......................................................................................... 15 2.1.1 The TSX Index (S&P/TSX Composite Index) ........................................................ 16 2.2 The Stockholm Stock Exchange .................................................................................... 16 2.2.1 The SSE Index (AFGX) .......................................................................................... 17 3. Literature Review ................................................................................................................. 18 3.1 The Efficient Market Hypothesis ................................................................................... 18 3.1.1 Weak form of market efficiency ............................................................................. 19 3.1.2 Semi-strong form of market efficiency ................................................................... 19 3.1.3 Strong form of market efficiency ............................................................................ 20 3.2 Function and application of EMH in market .................................................................. 20 3.3 Anomalies ....................................................................................................................... 22 3.3.1 Calendar anomalies ................................................................................................. 23 3.3.2 Fundamental anomalies ........................................................................................... 23 3.3.3 Technical anomalies ................................................................................................ 24 3.3.4 Other anomalies ....................................................................................................... 24 3.4 Momentum strategy ........................................................................................................ 25 3.5 Bull and Bear market ...................................................................................................... 26 4. Methodology ........................................................................................................................ 28 4.2 Research philosophy ...................................................................................................... 28 4.3 Research approach .......................................................................................................... 28 4.5 Data ................................................................................................................................ 30 4.6 Research design .............................................................................................................. 31 4.5 Testing the results ........................................................................................................... 34 4.6 Credibility criteria .......................................................................................................... 35 4.6.1 Reliability ................................................................................................................ 35 4.6.2 Replication .............................................................................................................. 35 4.6.3 Validity .................................................................................................................... 36 5. Results .................................................................................................................................. 37 5.1 Empirical findings of TSX ............................................................................................. 37 5.2 Empirical findings of SSE .............................................................................................. 38 5.3 Testing the results for TSX ............................................................................................ 39 5.4 Testing the results of SSE .............................................................................................. 39 5.5 Further test for the TSX results ...................................................................................... 40 5.6 Further test for the SSE results ....................................................................................... 41 5.6 Momentum and market movements (Discussion regarding the findings) ..................... 43 6. Conclusion ............................................................................................................................ 47 6.1 Conclusion of the study .................................................................................................. 47 6 6.2 Practical and theoretical contributions ........................................................................... 49 6.3 Suggestions for further research ..................................................................................... 50 7. References ............................................................................................................................ 52 7.1 References: ..................................................................................................................... 52 7.2 Further study .................................................................................................................. 53 7 LIST OF TABLES Table 1: Opinion of the Efficient Market Hypothesis (Block 1999) ........................................ 21 Table 2: Most important variable in determining portfolio returns (Block 1999) ................... 21 Table 3: The experimental model of the process ..................................................................... 33 Table 4: Result of the strategy (TSX) ...................................................................................... 37 Table 5: Result of the strategy (SSE) ....................................................................................... 38 Table 6: T-test for TSX results (Test Value = 0) ..................................................................... 39 Table 7: T-test for SSE result (Test Value = 0) ........................................................................ 40 Table 8: T-test for TSX results after excluding the year 2002 ................................................. 41 Table 9: T-test for SSE results after excluding the year 2002 ................................................